High Court

Michael Daly
										(Plaintiff)

v.

Revenue Commissioners, Ireland and the Attorney General
										(Defendants)

No. 367jr of 1994
[27th of July, 1995]

Status: Reported at [1996] 1 ILRM 122

Costello P. 
Dr. Michael Daly, the applicant herein, is a medical doctor who since 1985 has been a member of the General Medical Services Scheme providing medical services to eligible patients under a contract entered into with the Mid-Western Health Board. The fees to which he is entitled for the services he gives are paid by the General Medical Services (Payments) Board.
In Part III of the Finance Act 1987 provision was made for the deduction of income tax from payment for professional services by government departments, local authorities, health boards and certain statutory bodies. This deduction is usually referred to as a withholding tax. This can be a slightly misleading term because the scheme introduced in 1987 did not involve the imposition of a new tax but was in reality a scheme for the collection of income tax payable by certain self-employed professional persons. Like everyone else I am sure that Dr. Daly does not like paying income tax. It is however important to remember that his challenge in this case is not to the payment of the tax referred to in the Act, nor to the principle of collecting tax at source, nor does he raise any constitutional challenge to the method of collection as introduced originally in the 1987 Act. His challenge is to an amendment to the method of collection effected by the Finance Act 1990 which he says has caused him very great hardship and has resulted in an infringement of his constitutionally protected rights.

The withholding tax regime
(a)	The collection of tax
‘Accountable persons’ as defined by s. 14 of the Finance Act 1987 (and the board is an ‘accountable person’) are required since 6 June 1987 to deduct from payments made for professional services given by ‘specified persons’ (and Dr. Daly is a ‘specified person’) a sum equal to income tax at the standard rate in force at the date of payment. The sum deducted must be remitted on a monthly basis to the collector (ss. 15 and 17).
It will be noted that the sum representing tax is deducted from the gross amount of the fees payable to the specified person and as income tax is payable on profits (that is, gross fees less expenses) it is obvious that the tax collected during the year (called in the statute ‘the appropriate tax’) and forwarded to the collector will be greater than the tax which these fees will ultimately attract and may, depending on the existence of other income which the taxpayer may have, be greater than the total tax which the taxpayer may have to pay when his tax liability for the period in which deductions were made is finally determined.

(b)	Credit for tax collected
	When the tax payable by a ‘specified person’ comes to be assessed for any year of assessment he is required to include in his returns the full amount of the fee which he was entitled to receive from the board without taking into account the deductions made from it and paid over to the collector (s. 15(2)). He is then assessed to tax and when the assessment is finalised he is bound to pay over the sum due, like all other taxpayers. To avoid double-payment however provision was made in s. 18(2) for giving the ‘specified person’ credit for the sum collected at source. This provision had to take into account the fact that a self-employed person like Dr. Daly was, in 1987, subject to income tax under Schedule D Case II and tax was charged on profits and gains of the year preceding the year of assessment. This year was treated for the purposes of the 1987 Act as the ‘basis year’ for the year of assessment (s. 13(1)). S. 18(2) provided that when in relation to a year of assessment an individual bore withholding tax referrable to the basis period he could claim to have the amount of this withholding set against his income tax liability for the same accounting period and when the amount of the withholding tax exceeded his income tax liability for that period he was entitled to have the excess refunded to him.
There is no complaint about s. 18(2) as originally drafted; the double-payment effect was nullified because the amount of tax deducted during one accounting period could be set against the income tax payable for the same accounting period.

(c)	Interim refunds of tax collected
It was recognised that the scheme which I have just described could cause hardship not only because the amount deducted during any accounting period might be greater than the actual tax liability for that period but also because a delay could arise in finalising the tax liability for that accounting period. And so s. 19 contained provisions for the payment of an interim refund of the tax deducted in certain circumstances. This section has relevance to the issues in this case and I should briefly refer to it.
Before any refund can be claimed a statutory requirement must be satisfied; it must be shown that the profits of the ‘basis period’ immediately preceding that which is the subject of the claim have been finalised and the tax payable in respect of that period paid (s. 19(2)). The amount of interim refund, is a limited one. It is the excess of the total of the withholding tax deducted over the amount of the taxation paid in the previous accounting period (less certain other possible deductions which it is unnecessary to detail) (s. 19(3)).
In addition in a case of ‘particular hardship’ the Revenue Commissioners are empowered to waive compliance with the requirement and make an interim refund of such amount as they think is ‘just and reasonable’ (s. 19(5)).

(d)	The 1990 amendments
	A decision was taken relating to the assessment of self-employed persons which had consequences for the withholding tax regime which I have just described and which resulted in the amendments to it which have given rise to these proceedings. The decision was to amend s. 58 of the 1967 Income Tax Act so that from the year 1990/91 and subsequent years of assessment tax became chargeable under Case I and II of Schedule D on the profits and gains of the year of assessment, instead of on the profits and gains for the year preceding the year of assessment (s. 14 of the Finance Act 1990).
I will explain in a moment why it was considered necessary to amend the withholding tax regime consequent on this decision. The amendment with which we are concerned is to be found in s. 26(1) of the Finance Act 1990. This amended s. 18 of the 1987 Act (which, it will be recalled, allowed a credit for withholding tax against income tax liability) and added a new subsection. The result was that withholding tax deducted in any year of assessment is not available for credit against a taxpayer’s ultimate liability to income tax, pay related social insurance, health levy and employment and training levy in that year; the credit can only be claimed in the following year. This seemingly technical and innocuous amendment has had far-reaching consequences. To explain its effect I can refer to what happened to Dr. Daly for the year 1992/93. In the year 1992/93 deductions for withholding tax were made amounting to £10,965.41. His total income tax liability for the year 1992/93 was £11,697.26 and payment for this total sum was demanded even though the Revenue had already collected nearly £11,000 to pay the tax. A set-off of the deductions was requested. This was refused, the Revenue pointing out (correctly) that the sums deducted in 1992/93 were not available as a credit for the year 1992/93; they were only available as a credit for the year 1993/94.
Neither the grounds of opposition nor the affidavit filed on behalf of the Revenue explained why it was necessary to amend the credit provisions of s. 18 of the 1987 Act. In counsel’s submission the explanation was offered. s. 14 and 15 of the 1990 Act came into effect for the year 1990/91 and subsequent years and changed the basis for assessment from a previous year’s basis to a current year’s basis. Because this was done the year of account to 31 March 1990 fell out of assessment to income tax. In that year, however, self-employed professionals like the applicant (who had suffered a deducted £12,649.35) had had withholding tax deducted which entitled them to a credit. If no provision was made for this situation then all established taxpayers it is said would have been entitled to a refund of the tax collected and so would have obtained what was referred to as a windfall gain. This was considered to be unacceptable and the solution that was adopted to deal with the situation was to alter the period when credit could be given in respect of the withholding tax paid over by postponing the credit to the year after the withholding tax had been collected.
It is to be noted that whilst the problem arose in the transition from one method of assessing certain taxpayers to another method, it was dealt with not by a transitional provision but by permanently altering the method by which tax collected at source was credited. It is also to be noted that the adverse consequences are permanently borne not just by those 1991 established taxpayers who might have benefited from the windfall gain, but also by all new entrants into the withholding tax regime who would not have obtained any windfall gain but who will suffer this method of crediting withholding tax during the whole of their professional lives.
In reply to the reasons offered for the 1991 amendment the applicant submits that they may indeed constitute an explanation for what was done but the amendment had the effect of rendering s. 18 of the 1987 Act unconstitutional.

The operation of the regime
The challenge in these proceedings is to the 1990 amendment. But the amendment cannot be considered in isolation – to understand its operation and consequences it is necessary to understand the operation and consequences of the other provisions of Part III of the 1987 Act.
Firstly, it is necessary to bear in mind, as has already been pointed out, that the withholding tax deducted is based on the gross fees payable to the taxpayer, that is before any expenses have been deducted. Thus the withholding tax deducted will be greater than the income tax which ultimately will be assessed on the fees, and may be greater than the taxpayer’s total liability for income tax, depending on the level of deductible expenses and the taxpayer’s other income. This point is illustrated by the applicant’s experience. The applicant’s expenses as a percentage of his gross income was to the year ended 31 March 1992, 71% (for exceptional reasons to be explained later), for the year ended 31 March 1993, 36%, for the year ended 31 March 1994, 43% so that his tax liability on the fees was considerably less than that which the gross figure attracted. And in a six year period ending 31 March 1994 his total income tax liability (based on fees from private practice as well as from the G.M.S. Scheme) was less than the sums deducted by way of withholding tax (except for one year).
Secondly, the effect of deducting withholding tax is to reduce the funds available to the taxpayer to meet his income tax liability at the end of the year. If the withheld tax cannot be used as a credit against that liability (which is the result brought about by the 1990 amendment) then obvious financial hardship must result.
Thirdly, the result of deducting withholding tax from fees payable to a taxpayer but not permitting the sums to be set-off against the tax payable on the fees and requiring its immediate payment means that the taxpayer is required by law to suffer what amounts to a double payment of tax (the deduction at source and the later payment).
Fourthly, the statutory provisions (of s. 19) designed to mitigate the hardship which it is recognised may result from the operation of the regime do not adequately fulfil this function, as the applicant’s experience, referred to below, establishes.
The operation of the regime in the applicant’s case produced the following results:-
(a)  As already pointed out, the income tax payable by the applicant for the year of assessment 1992/93 (after allowing a credit for £2,442 in respect of the withholding tax deducted during 1991/92) amounted to £11,697.00. Withholding tax deducted in the year 1992/93 amounted to £10,965.00. On 15 April 1994 the applicant wrote requesting that on the basis of personal hardship (under s. 19(5)) a credit should be allowed for the sum deducted at source. This request was refused. A second request was not answered and on 6 July 1994 his solicitor wrote claiming an entitlement to set-off (under s. 18(2)) and remitting a cheque for the balance of tax payable (£732.00). The right to set-off was denied by letter of 28 September and on 9 November 1994 the applicant paid the balance of the tax claimed.
Meanwhile by order of 17 October 1994 liberty to institute these proceedings was given. On 18 November 1994 the Revenue Solicitor wrote stating that in error the applicant was entitled to a refund of £8,523.32. It is important to note that this was not a credit under s. 18(2) (the 1990 amendment did not allow such a credit to be given), nor an interim refund on the basis of hardship under s. 19(5), but (as explained in a later letter) was an interim refund under s. 19(3).
(b) Since these proceedings were instituted the applicant’s accounts for the year of assessment 1993/94 have been finalised. He has obtained an interim refund (under s. 19(3)) of £787.58. On 1 March 1995 an income tax assessment was raised for the years 1993/94 which shows that his income tax liability for the years was £11,042.58. Because he had paid £2,500 by way of preliminary tax and was entitled to a credit for the year 1992/93 of £2,442.00 and for the year 1993/94 of £787.58 the balance of the tax payable was £7,521. This sum was duly paid. Because in the year 1993/94 the sum received by the Revenue by payment of withholding tax on the applicant’s fees was £14,139.00; because in respect of that year it also received £2,500 by way of preliminary tax and £7,521.00 on foot of its demand of 1 March, the Revenue now holds in respect of the year 1993/94 £24,160 (which is a sizeable slice of his total gross income from fees under the GMS Scheme of £37,308).
(c) The refund provisions of s. 19 of the Act were not of significant benefit to the applicant in assisting the discharge of his current tax liabilities and the detailed figures over a six year period clearly suggest that, viewed over that period, they do not mitigate the hardship imposed by the provisions impugned in this application. In the six year period from the year ended 31 March 1989 to the year ended 31 March 1994 the total withholding tax deducted from the applicant’s fees was £68,813.80. But his total liability to tax during that period was only £42,461.47, so that the Revenue collected over this six year period sums considerably in excess of the applicant’s tax liability. S. 19 only partially alleviated that position as interim refunds under s. 19 only amounted to £33,101.50. Furthermore, the figures establish that in each year (other than the year ended 31 March 1993) the withholding tax collected exceeded the subsequently agreed tax liability and in each year significantly exceeded refunds made under s. 19.
(d) The applicant’s evidence (which I accept) is that the introduction of the withholding tax regime caused him severe financial hardship and stress and that he was forced to borrow on overdraft from his bank to pay his day-to-day expenses of his practice and current tax liabilities. He says that since the 1990 amendment and the current year of assessment came into effect (from the year of assessment 1990/91) his situation has become intolerable. Because of strain he was forced to take a long break in the year of assessment 1990/91 and employ a locum. This of course greatly increased his expenses and caused a drop in his profits to £12,130.00. He returned to full-time practice in 1992/93. His indebtness to his bank when the proceedings were instituted was £12,000.00 and his position then was that he needed to borrow further to meet his ordinary commitments to his practice as well as his tax liabilities.
It was urged on the respondents’ behalf that the figures show that the applicant’s complaint about the operation of the system is no longer justified and that the credits postponed from the year in which withholding tax is deducted to the following year of account now produces equilibrium and no financial hardship or injustice. But this argument ignores an inherent characteristic of the system; a diminution in fees (due, for example, to illness or fluctuations in payment) in one year means that there will be a reduction in withholding tax in that year and that in the following year the credit available will also be correspondingly reduced. If in the following year fees are increased, then the credit available against the increased income tax liability in that year will be inadequate to meet it.

The legal issue
The State is constitutionally obliged by its laws to protect from unjust attack the property rights of every citizen (Article 40.3.2°). There is no doubt that the system of tax collection which these proceedings challenge amounts to an interference with the applicant’s property rights in the fees he has earned under the GMS Scheme. This much is common case. But legislative interference in property rights occurs every day of the week and no constitutional impropriety is involved. When, as in this case, an applicant claims that his constitutionally protected right to private property referred to in Article 40.3.2° has been infringed and that the State has failed in the obligation imposed on it by that article to protect his property rights he has to show that those rights have been subject to ‘an unjust attack’. He can do this by showing that the law which has restricted the exercise of his rights or otherwise infringed them has failed to pass a proportionality test - a concept which I considered in Heaney v. Ireland [1994] 2 ILRM 420 and which Keane J more recently considered in Iarnród Éireann v. Ireland [1995] 2 ILRM 161. In Heaney I quoted the test as formulated by the Canadian Supreme Court as follows (at p. 431):-

The objective of the impugned provision must be of sufficient importance to warrant overriding a constitutionally protected right. It must relate to concerns pressing and substantial in a free and democratic society. The means chosen must pass a proportionality test. They must:-

(a)	be rationally connected to the objective and not be arbitrary, unfair or based on irrational considerations,
(b)	impair the right as little as possible, and
(c)	be such that their effects on rights are proportional to the objective. Chaulk v. R. (1990)3 SCR 1335-1336.

The objective of Part III of the 1987 Finance Act is, like all legislation permitting the collection of tax at source, to assist the collection of tax and to prevent avoidance. In addition it had a specific objective, namely to minimise the difference in the way employed professionals (who are subject to the PAYE system) and self-employed professionals are treated in the tax system. But the withholding tax regime as enacted by Part III is not challenged in these proceedings - it is only the amendment to s. 18 brought about by s. 26 of the 1990 Act. It seems to me therefore that the court is not concerned with considering the general objectives of Part III of the 1987 Act but must focus on the specific objective sought to be achieved by the amendment. As pointed out already, the object of the amendment was to avoid the payment of a windfall gain to established taxpayers arising from the change in the basis of assessment from a previous year’s basis to a current year’s basis which ss. 14 and 15 of the Act had effected. If it can be shown that the means chosen to achieve that end fails to pass a test of proportionality then the court must conclude that the infringement of the applicant’s constitutionally protected rights is impermissible. However, in applying this test the court must take into account the context in which the amendment was made as the effect of the means employed to obtain the section’s objective will be influenced by the other provisions of the regime in which the amendment is made.

Conclusions
I think the s. 26 amendment fails the proportionality test for two reasons. Firstly, the effect of s. 26 of the 1990 Act is to alter the credit arrangements contained in s. 18 of the 1987 Act so that the withholding tax deducted is not available as a credit against liability for the income tax payable in the year of assessment in which it was deducted. This seems to me to produce results which are manifestly unfair to established taxpayers. It causes them hardship in that:-
(a) the collection of withholding tax reduces their ability to pay the income tax which it has been collected to discharge, and
(b) it requires double payment of tax.
This unfairness is not mitigated by the interim refund provisions which inadequately deal with the anticipated hardships which the regime imposes and indeed it is exacerbated by the fact that withholding tax collected over a period may exceed the taxpayer’s total liability for tax. Secondly, the effects on the taxpayer’s property rights is not proportional to the objective to be achieved. The section was designed to deal with a transitional situation (namely a windfall gain arising in one year from the change in the basis on which the self-employed were taxed) but in doing so it has imposed a permanent measure which involves a permanently unfair method of collecting tax. And this effect is borne not only by established taxpayers who might have enjoyed the windfall gain if the amendment was not enacted but also by new entrants to the regime who would have obtained no benefits in 1991.
The respondents accept that the problem posed by the creation of a windfall gain could have been dealt with differently but urge that this was a matter for the Oireachtas and not for the courts to decide. I agree. This Court has neither the jurisdiction nor the competence to say whether or not the taxpayers should have been allowed to enjoy a windfall gain in 1991 or how the objective envisaged by s. 26 could best be achieved. But it can examine the measure actually adopted and decide whether or not the interference with property rights has been brought about by means which are unfair to individual taxpayers or affect property rights in a manner out of proportion to the objective which the measure is designed to achieve. As I have reached a conclusion on these matters unfavourable to the amendment I must declare s. 26(1) of the 1990 Act to be unconstitutional and therefore invalid. I will hear counsel on what further orders (if any) the applicant is entitled to consequential on this declaration.